I have been a critic of oil and gas company InterOil (IOC) for awhile, and have shorted the stock from time to time. I like having a short position now, because the stock has risen quite a bit in the last couple weeks, and there is a clear catalyst ahead. In the next 30 days, if InterOil doesn't have a clear deal in place to sell down some of its assets, I believe the stock will drop back down to the $50s and soon after the $40s. I have seen this movie play out several times before with InterOil, the latest one was just a few months ago.
I believe if InterOil really was able to make a deal, it would just do it! Other oil and gas companies, and even companies in other sectors, don't need to make such a big public spectacle every time they are trying to sell an asset or partner up with another company. Usually you never even hear rumors of a buyout or partnership, it just happens unexpectedly. InterOil, however, always provides the sizzle, but to this day, the steak has never arrived.
On January 23rd, IOC stock was tumbling and I believe the management felt it had to do something to reverse the drop. Intraday, it had fallen over 10% at one point. Management then made an announcement the morning of January 24th that InterOil will close the bidding process on February 28th, and then choose a partner in the first week of March. This announcement was out of the blue and a surprise to everyone. There is no fundamental reason why InterOil had to tell this to the public. Management could have just privately told it to the potential partners that were bidding on the gas wells. But desperate times call for desperate measures, and this announcement succeeded in creating a rebound in the stock. Unfortunately for long term shareholders, I don't think anything solid will come of this.
When researching stocks, I often go on message boards to get the point of view of other investors. A few days ago, I was reading the IOC Yahoo message board. On it I read a reposted quote from hedge fund manager Whitney Tilson that said:
This is a company that has NO RESERVES - not proven, probable or even possible; just a 'contingent resource estimate' from a firm that InterOil paid, after shopping among firms - and has NEVER delivered on its countless promises of huge natural resource finds in over 200 press releases over more than 10 years. Sure, there's gas there - this isn't Bre-X - but we think there's only a tiny fraction of what IOC claims.
--- Whitney Tilson
I agree with Tilson's statement. It's also interesting that he mentioned Bre-X, which ironically has many things in common with InterOil.
Is InterOil Another Bre-X?
If you don't know the story of Bre-X, you can read about it on Wikipedia here. It's a fascinating story. In summary, Bre-X was a Canadian company in the 1990s that claimed to own a huge gold deposit in Busang, Indonesia. Bre-X bought the land in 1993, and in 1995 announced a large amount of gold had been discovered. Originally a penny stock, Bre-X reached its peak market capitalization of over CAD $6 billion in 1996. However, in 1997 the gold samples were exposed as being a fraud, and the stock collapsed. Bre-X eventually went bankrupt and the stock went to zero.
While InterOil hasn't been proven yet to be a fraud, investors should be wary. The company's delays, relentless promotional activity, and unreliability over the past decade make it look very shady. The company hasn't done anything that disproves that it isn't a story like Bre-X. The following are interesting comparisons between Bre-X and InterOil:
1. Both claimed to have large resource deposits. Bre-X claimed to have a luscious gold mine. InterOil claims to have wells brimming with natural gas.
2. Both had its resources in tropical, developing countries. Bre-X had its gold deposit in Indonesia, InterOil has its gas wells in Papua New Guinea.
3. Both hired an independent consulting company that estimated a gargantuan amount of resources. Bre-X hired Kilborn Engineering, which estimated the gold resource to have approximately 70,000,000 ounces of gold. InterOil hired GLJ Consultants which in 2010 reported estimates of 8.59 trillion cubic feet (Tcf) of natural gas and 128.9 million barrels of condensate (MMBls).
4. Both companies had similar large market caps at their peak. Bre-X's market cap peaked at CAD $6 billion, InterOil's has peaked at $4.4 billion.
5. Both governments required a major operator to help extract the company's resources. The Indonesian government stated that a small company like Bre-X could not exploit the site by itself, so suggested that it share the site with a large mining firm. Bre-X had Freeport-McMoran (FCX) conduct due-diligence on the gold mine. The results showed "insignificant amounts of gold" and a frenzied sell-off of Bre-X shares ensued.
The Papua New Guinea government similarly required that InterOil partner with a major gas and oil operator. As I explained in a past article, in September 2011, InterOil hired three investment bankers, Morgan Stanley, Marquarie, and UBS to find a major partner, and none have so far created a single deal for InterOil. The firms were supposed to find a partner within six months.
Late last year, InterOil led the public to believe a deal with a major partner was imminent, which is why the stock rose to as high as $90 per share in September 2012. When a deal didn't materialize, the stock proceeded to go as low as $51 in December, for an almost 50% drop because of the investing public's growing doubt.
Unlike Bre-X, which eventually allowed a major to inspect its mine, InterOil hasn't given a major the opportunity to conduct due-diligence on its gas wells. Royal Dutch Shell (RDS.A) was supposed to be a potential major partner for InterOil. However, Simon Henry, Shell's CFO, is reported as saying:
"At the end of the day we haven't been in the data room and we're not in an ongoing discussion. It's very difficult to have an interest in the asset that the license holder [InterOil] doesn't want to talk to you (Shell) about," Mr. Henry said.
If Shell had the opportunity to inspect the wells, then it's possible that a similar ending would happen to InterOil as what happened to Bre-X. No major oil and gas operator has made a serious inspection of InterOil's resources, and none has devoted any material amount of capital in them.
Some investors have faith in InterOil and think that it hasn't been able to make a deal in over ten years because of mitigating circumstances. I'm not one of those investors. If you want to take a gamble and buy the stock, go ahead, but be fully aware of the possibility that the company is a fraud.